What Is a Cash Out Refinance? (Clearing The Fog)

What Is a Cash Out Refinance? (Clearing The Fog)

It used to be that one of the goals of homeownership was to eventually pay off your home loans and live in your house mortgage-free. Sucker! Nah, just kidding. But it is true that in the past couple of decades, that kind of mindset has kind of gone by the wayside for a lot of people.

Why? Well, for one thing, tax laws that let you deduct your mortgage interest are a big plus for a lot of homeowners: Pay off your mortgage and you lose one of the biggest tax advantages available to the average (i.e., not super-rich) person.

Also, while your parents or grandparents may have had a difficult time accessing any equity they’d built up in their home over time, many lenders today have made it easy to tap into that equity with equity loans, lines of credit and the ever-popular cash-out refinance.

So just what is a cash out refinance? The concept is actually pretty simple: As you pay off your mortgage – and if your home increases in value, as most homes tend to do in “normal” housing markets – eventually, you’ll have a significant gap between what you owe on your home and what it’s worth; that’s the equity that’s freed up in a cash-out refinance. A cash-out refinance lets you refinance the terms of your loan and place a new and bigger mortgage on it, enabling you to have access to that equity.

For instance, say you have a mortgage of $150,000 remaining on your home. Over time, the value of your home has increased to $250,000. That $100,000 difference is the equity you have in your home, and thanks to the cash-out refinance, it could be burning a hole in your pocket in just a few weeks.

Of course, you typically can’t access the entire amount of your equity. Usually, you’re limited to a loan-to-value (LTV) ratio of about 80%, although some lenders may allow 90% LTVs (generally with a significantly higher interest rate as well as points – and you’ll also have to pay private mortgage insurance).

There are lots of reasons to cash out:

• Pay for college tuition for your kids or yourself
• Afford that wedding of your dreams – or your child’s dreams
• Get those renovations done on your home – and increase your equity all over again in the process
• Buy an investment property
• Start a new business and thumb your nose at your corporate gig

No matter what the reason, that equity is your money. Why keep it locked up in your house? A cash-out refinance means you can access that value and still save money by taking advantage of today’s low rates.